Dissing Deflation

It sounds like a good thing right - deflation? Lowering prices; its like a constantly improving sale. Except that its arguably more scary and threatening than inflation. Inflation represents a growing economy. Sure your money isn't worth as much as it was yesterday, but the idea is that (with controlled inflation) the economy is growing and, thus, the increase in sales, etc make up for that lost purchasing power.

With deflation, its a scary cycle. Yes prices are lower and one dollar buys more today than yesterday - but the things that typically coincide with macro-deflation make it a lucky few who get to enjoy the "sale" side of it all. Deflation means less corporate profitability which can mean declining GDP growth, which can lead to job cuts, which can lead to less consumer spending - foreclosures - and before you know corporations have to lower prices again so things are affordable to the average Joe. But again, less profits, and the vicious cycle becomes a self-sustaining model of decline.

The typical weapon to fight this is with the Fed Reserve - flooding the economy with easy money via 0% interest rates and the like - which its done. And for that, we should be thankful. Inflation is currently hovering around the 1.4% range year-over-year. It's below a conservative and more encouraging goal of say 3%, but it's still inflation. It's proof of a pulse in an economy that is trying to reduce debt and sustain spending in order to cultivate growth all at the same time. It's a balancing act that determines the future of the economy, the confidence of the people and the prudence and priorities in our personal and national budgets.

So far so good. While deflation is more of a threat than inflation, it doesn't appear to be the expected outcome at this point. Consumers have adjusted over the past 18 months to save more -- but yet are spending enough to generate an economy that produces somewhere between 1 and 2% GDP growth. Again, below a healthy 3%, but growth is growth. Moreover, businesses are maintaining razor thin inventories, which helps fight deflation (prices stay higher if supply is less). The weak US dollar provides export growth which helps economic growth and corporate profitability. And the Fed Reserve plans to not only maintain its 0% interest rate throughout 2010 (and probably 2011) but also has the capacity to purchase treasuries, mortgage backed securities and the like to sustain a constant flow of easy money in the system.

The threat... deflation is nearly as psychological as economic. It doesn't take much more than a frantically fearful and panicked consumer to halt spending and begin the trip downhill...less corporate sales = less hiring, maybe job cuts = higher govt deficits to support and more housing issues with delinquint payment and foreclosures = bank profitability declining and less lending in general = no one able to afford goods at current prices = lower prices = less corporate sales/profitability = ....

The best news is that minimal job growth and economic growth is occuring EVEN WITHOUT the government's help - and I'm not sure more is prudent given the already existing deficit issues. So the economy appears able to stand, feebly, and deflation at bay. As long as things continue to play out in this methodically painful manner, things look good. Rock the boat and the Fed should step in -- at that point, deflation may not be the D word we're worried about; we may be setting the stage for a Grecian tragedy instead.